ProBMP4 is initially cleaved at a site adjacent to the mature ligand (the S1 site) allowing for subsequent cleavage at an upstream (S2) site. Mature BMP4 synthesized from a precursor in which the S2 site cannot be cleaved remains in a complex with the prodomain that is targeted for lysosomal degradation, and is thus less active when overexpressed in Xenopus. Here we report that mice carrying a point mutation that prevents S2 processing show severe loss of BMP4 activity in some tissues, such as testes and germ cells, whereas other tissues that are sensitive to Bmp4 dosage, such as the limb, dorsal vertebrae and kidney, develop normally. In a haploinsufficient background, inability to cleave the S2 site leads to embryonic and postnatal lethality due to defects in multiple organ systems including the allantois, placental vasculature, ventral body wall, eye and heart. These data demonstrate that cleavage of the S2 site is essential for normal development and, more importantly, suggest that this site might be selectively cleaved in a tissue-specific fashion. In addition, these studies provide the first genetic evidence that BMP4 is required for dorsal vertebral fusion and closure of the ventral body wall.